MONEY & REAL ESTATE

Depressed Asian market invites foreign investments Southeast Asian commercial real estate markets have experienced drastic declines in property values during the past year. Thanks to major devaluations, banking problems and slower overall growth, market values of shopping centers, office buildings, industrial buildings and even apartments have plunged. In Hong Kong, commercial property values have fallen about 50% and residential values about 40%. In Bangkok and Jakarta, some modern commercial properties have fallen as much as 80% in value, and many properties under construction have been stopped half-built. This column explores the causes of this disaster and its likely near-future course.

In a November 1995 article in the Asian Wall Street Journal, I predicted a coming collapse in commercial property values throughout Southeast Asia. I made this prediction in the midst of an on-going boom in new development throughout the region - a boom that continued for many months thereafter. That boom resulted from six major factors: (1) rapid and sustained growth in the overall economies of most Southeast Asian nations, mostly over 5% per year; (2) the entry of many more households into modern market economies from traditional self-sustaining rural economies; (3) rapid conversion of traditional shop and office space into modern facilities; (4) strong tourism throughout the region; (5) a huge surplus supply of private equity capital eager to invest in something; and (6) a resulting exuberant optimism about future retail sales growth, office occupancy and manufacturing production among real estate developers, lenders and equity investors.

In spite of all those positive forces, I forecast a near-future collapse of property values from one reason: massive and reckless overbuilding of all types of space in many Asian cities. These included Jakarta, Bangkok, Kuala Lumpur, Seoul, Shanghai and Kaohsiung (on Taiwan). Overbuilding was less prevalent in Tokyo and Hong Kong, but property values had already fallen sharply in Tokyo and were so overvalued in Hong Kong that future declines were inevitable.

Reasons for depressed Asian property values

* Falling levels of gross domestic product

* Massive defaults of bank loans to domestic firms

* Massive defaults of domestic borrowing from abroad

* Defaults led to huge withdrawals of short-term capital, therefore causing devaluation in local currencies

* A shift of people from rural areas into urban markets reversed as millions returned to villages, cutting demand for space

* Tourism of the region plunged

My prediction proved even more powerful than I anticipated, because nearly all the positive forces then operating in Asian property markets have reversed themselves since 1995. The rapid growth of most Southeast Asian economies has been replaced by falling levels of gross domestic product nearly everywhere except Taiwan, China and Singapore. As of August 1998, gross domestic products were down year over year by 5% in Hong Kong, 16.5% in Indonesia, 6.6% in South Korea, 0.4% in Thailand and 1.2% in the Philippines. (Japan had already experienced negative growth.)

These slowdowns were caused by massive defaults of bank loans to domestic firms, triggering equally massive defaults of domestic borrowing from abroad. Japanese banks had been making short-term loans to firms throughout Southeast Asia at irresistibly low interest rates, because borrowing was so cheap in Japan. Defaults on those loans led to huge withdrawals of short-term capital from these nations by foreign investors, causing giant devaluations in local currencies against the yen and dollar. When Indonesia's currency devalued by more than 50% against the U.S. dollar, the domestic interest burdens of all dollar-denominated debts more than doubled overnight - generating massive further defaults.

The resulting banking crises in all these nations, plus inability to raise any foreign capital, slowed their firms' ability to continue business, let alone grow. Hence, their overall economic growth disappeared. Their shift of people from rural areas into urban market economies reversed itself as millions returned to their villages, further cutting demands for space. Also, tourism plunged as potential foreign visitors shied away from possible political and monetary instability. The once-abundant supplies of equity and debt capital vanished. So exuberant optimism has been replaced by gloomy pessimism.

In the recent past, economic slowdowns in this region have rapidly ended, and notable growth has resumed within one or two years. However, I doubt if that will happen this time. The most important determinant is how fast the Japanese banking system - the single-biggest source of capital for this region - can be put back into effective operation. Although the Japanese government has recently made some important moves toward bailing out its troubled banks, it has a long way to go to restoring enough confidence to permit those banks to resume supplying long-term capital to the rest of Southeast Asia. Moreover, some steps needed to achieve this outcome involve major reforms in Japan's electoral and bureaucratic structures. Entrenched Japanese politicians, bureaucrats and business interests have resisted such reforms for years. As of November 1998, the Japanese stock market was about 66% below its peak in late 1989, and real property values have plunged more than 60% with no recovery in sight. Yet Japan has not yet acted under the pressures generated by those huge asset-value collapses.

Indonesia, too, needs to adopt major political reforms in order to restructure its sagging economy. Yet such reforms are always hard to carry out - witness the U.S. Congress's failure to adopt relatively superficial campaign finance reform. And all other Southeast Asian nations need to make major changes in their banking systems and regulations, as well as to sell off bad assets on their banks' books at rock-bottom prices and to absorb the losses in the public sector. Only then can the economies in this region return to healthy, positive growth rates.

Meanwhile, consumers throughout the region have drastically reduced their retail spending, both because their incomes have plummeted and because they are experiencing psychological shocks from falling stock and housing prices. It will take some time before they come back into retail markets at their previous levels.

For all these reasons, I believe property values in Asian markets will remain depressed - though not necessarily as low as they are now - for several years. This has created an opportunity for foreign-financed "vulture funds" to buy quality assets there at low prices. Many operators of such funds have already shown up in Japan and elsewhere, although only a few major deals have been made so far. But more will be made during this overbuilt period in the Southeast Asia real estate cycle.